As FTX Fallout Continues, Here's How to Protect Your Crypto Assets Against Platform Failure

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  • Crypto platform failure can be stressful and costly for retail investors.
  • Using a non-custodial crypto wallet puts you in control of your assets.
  • Keep detailed records so you can prove what you bought and sold.

Take these steps to ensure your assets don't get swallowed up if your crypto exchange fails.

Brace yourselves. When a crypto giant like FTX collapses, it can shake the whole system and cause aftershocks that will be felt for some time to come. The trouble is that many crypto platforms are connected financially in different ways. When one fails, it can cause a domino effect. Right now, that leaves many investors wondering what they can do to protect themselves. Here are three routes to explore.

1. Consider a non-custodial wallet

"Not your keys, not your crypto" has long been a rallying cry from crypto veterans. Crypto keys are essentially the codes that allow you to manage your crypto. Think of a crypto wallet as a kind of like a key ring -- it's a place to store your keys. Crypto wallets come in different forms, and it's good to understand how they work.

When you leave your cryptocurrency on the exchange where you bought it, you are using what's called a custodial wallet. The exchange controls the keys to your crypto. If something happens, the exchange can freeze your account and stop you from accessing your assets. That might be the result of various things, including a platform hack, liquidity issues, or security concerns about your activity.

But if you move your funds to a non-custodial wallet, you are in control. If the platform collapses, your funds can't get pulled into any bankruptcy proceedings because you hold the keys. That's why it is one of the best protections against platform failure. The main types are hot wallets that are connected to the internet, and cold wallets that are mostly kept offline. Cold wallets are more secure, but not as easy to use.

Crypto wallets have some drawbacks when compared to crypto exchanges:

  • They are not as user-friendly as they could be, and they require a certain amount of technical know-how.
  • If you lose the password and security phrase for your wallet, you could lose access to your crypto completely.
  • You are completely responsible for the security of your crypto. If your computer is infected with a virus or malware, your crypto assets could be at risk.

One of the issues with what's emerging from FTX is a question of trust. Crypto is still a relatively unregulated industry, and as a result, we don't always know what centralized exchanges are doing with our money. But part of the attraction of crypto is that it's decentralized. With a little effort, you can be your own bank and not rely on any centralized bodies or middlemen.

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2. Keep detailed records

When the FTX website went down, so did many customers' access to their transaction histories and activity reports. Don't rely on a crypto exchange to store that information for you. Set a calendar reminder to log in each month and download your latest activity. Or keep records of each transaction as a matter of course.

There are two reasons for this. First, in many countries, you need to report your crypto transactions on your tax filing. If there's even a chance your crypto exchange won't be there come tax day, you'll need to have your own records so you can complete that filing.

The other reason is that if the worst happens and your exchange fails, you may need evidence of your holdings to have any chance of reclaiming at least some of your funds. The FTX site is now down and there's no indication that it will come online again, which could further add to the woes of some of its customers.

3. Don't take their word for it

The picture that's emerging of FTX is deeply disturbing. Among other things, an initial court filing from the new CEO highlighted missing funds, serious mismanagement, and internal system failures. FTX founder and CEO Sam Bankman-Fried was a rising star in the crypto world, and until the final weeks, few people had reason to distrust him.

However, it would be wrong to assume that all crypto exchanges are untrustworthy. The challenge is that because there is so little regulation in this space, it can be hard for retail investors to spot any dodgy dealings. Here are some signs to look for when comparing crypto platforms:

  • Third-party audits of assets
  • Third-party insurance against crime
  • FDIC insurance on dollar deposits
  • How platforms use leverage

FDIC insurance was created to give consumers more protection against bank failure, after some huge bank collapses during the Great Depression. It does not cover cryptocurrency assets. However, some platforms (such as Coinbase and Gemini Exchange) hold U.S. customers' dollar deposits in FDIC-insured bank accounts, which at least protects that money.

Several top crypto exchanges have released or are promising to release audited proofs of reserves, which goes some way to showing that there are no holes in their balance sheets and customer assets are fully backed. CoinMarketCap has released a new reserve tracker tool, which may help investors in this respect.

Bottom line

Learning how to protect your crypto assets is a core part of crypto investing. We talk a lot about volatility and the potential for individual coin's value to fall dramatically, but the failure of an individual crypto platform can be equally damaging, if not more so. Be sure to follow the golden rule of crypto investing and only invest money you can afford to lose. That way, if your platform does fail, it won't devastate your finances.

If you don't want to manage your own crypto wallet, that's understandable. But you might want to prioritize security and transparency when choosing a crypto exchange. You might even opt instead for safer investments with established institutions such as banks or brokerage firms. Until there's stricter regulation in crypto, you'd be forgiven for making comparisons to the Wild West.

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